Tuesday, February 10, 2009

Well, This Sucks...

I don't often post stock analyst assessments, but this one from Robert LaFleur at Susquehanna Investment Group was so pointed and dire -- and depressing -- that it was worth posting. There's a document attached to this summary, but the summary is enough to make anyone whose livelihood and fortunes are remotely connected to the success of Las Vegas to want to jump off the Eiffel Tower, real or replica. Here goes:

Stripping It Down: Is Las Vegas Boulevard the New Skid Row?

We think that Las Vegas operators face the most treacherous period in the Strip's 68-year history. Since 1990, we have seen a ten-fold increase in capital deployed on the Strip and only a five-fold increase in profits. Even so, the past five years brought about a big run-up in leverage and equity valuations. Unfortunately, the profitability of today's Vegas operators is overly dependant on a foundation of high room rates that is simply not sustainable in the face of the severe consumer pull-back we now confront. Operators that are being forced to aggressively discount room prices to fill their properties are seeing severe negative operating leverage wreak havoc on profitability. Overleveraged and facing dysfunctional capital markets, Las Vegas can ill afford this crippling rate war. While the Street has been aware of these trends for over a year and $90+ billion of public gaming equity has evaporated, we think things are even worse than many perceive. Despite this massive correction, we do not believe we have yet reached bottom. As a result, we have again reduced earnings estimates for the Vegas-exposed operators in our universe and downgrade MGM and WYNN, and reiterated our neutral view on LVS.


  • A good story gone bad. It is tough to lose money in the gambling business. In the early 1990s, the dawn of modern Las Vegas, profits and returns were attractive. Over time, the casinos got bigger, fancier, and costlier. Rising profits failed to keep pace with capital spending and returns fell. Cheap debt and equity fueled the fire and by mid-2008 the Strip was exceptionally vulnerable to the severe downturn that arrived.
  • A tale of two myths. The run up in leverage and multiples in the post-9/11 era was built on two myths. First was the industry's "recession resistance," its experience in the early 1990s and after 9/11 as gaming seemed immune to the consumer cycle. The second was that Strip properties "weren't in the casino business anymore," as their revenue had diversified away from gambling so their earnings were inherently less volatile. As rooms operations became a major profit source, it was argued that Strip operators should trade at higher lodging-like multiples, not traditionally lower casino multiples. Unfortunately, given the price elasticity of demand in Las Vegas, properties more reliant on rooms revenue than gaming revenue are riskier and more cyclical.
  • Room rates, room rates, room rates. While the square footage of casino space on the Strip increased 2.6x from 1990-2008, casino department profits per square foot only grew about 0.6% per year. By contrast, hotel rooms on the Strip increased 2.8x over that period, but hotel department profits per available room grew about 6.4% per year. By 2008, casino operations only generated about 35% of department profits on the Strip, down from 62% in 1990. By contrast, rooms generated 39%, up from 25%. Looked at another way, rooms operations produced almost twice as much of the collective department profit growth on the Strip from 1990-2008 than casino operations did. Given the high operating leverage of rooms operations - both positive and negative - overall Strip profits are now very vulnerable to a collapse in room rates.
  • What's next? Las Vegas is now tied to the economy so the economy needs to firm. Assets needed to be re-priced, but the $90 billion of public equity that has been wiped out took care of that. Likewise, gaming must complete the painful de-leveraging process it is currently in. Looking ahead, we think the cost of capital will rise as spreads and equity multiples return to their pre-9/11 ranges. Moreover, we think that in order to be relevant in a post-prosperity society, Las Vegas needs to rediscover the value proposition that it moved away from this past decade. Finally, gaming as a unit growth story is over. Going forward, managements will need to focus on prudent, returns-oriented capital deployment and operational cash flow maximization. Instead of unit growth, free cash flow should be deployed for de-levering, buybacks, and dividends. This will be a dramatic but necessary change in the way gaming companies have operated for the past 20 years, but it will insure gaming's viability.
  • Limited equity value left. As we detail in the accompanying reports, this dire situation will pressure the earnings of MGM, LVS, and WYNN. It is hard to find equity value in MGM, so we have downgraded it to Negative. WYNN has a survivor's balance sheet, but it is hard to paint a bull scenario. While we think WYNN is the best of breed among the Las Vegas operators, right now that is a bit like having the nicest cabin on a sinking ship, so we are downgrading WYNN to Neutral. LVS is fairly priced and we remain Neutral.

Wasn't that FUN?


Tom said...

One thing they don't talk about is the oncoming opening of several more casino's adding thousands of mostly high end rooms to the inventory of an already hurting market. 2009 and 2010 are going to be brutal years for Las Vegas Operators and employees. This is good news, however, for consumers. Travelers to Las Vegas will reap the benefits in lower overall trip costs.

Mr E in Santa Cruz said...

This just echoes what we already know to be true.; nothing lasts forever. People could not even contemplate that things could ever change, let alone go this bad. From what little I know about how these corporations are run, I’m not surprised they call out WYNN as best of breed. Steve Wynn seems to understand the cyclical nature of the industry, however I’m not sure how he would agree that “Gaming as a unit growth story is over”.

You can see the ripples of this if you drive down some of the main streets in Las Vegas ; it seems like every block has a few spaces for lease where there use to be small shops and nearly every street has at least one house for sale or vacant. The city of Las Vegas grew fast and hard on the two myths and now seems to be the hardest hit by the economic downturn.

mike_ch said...

Much of the stuff here is already built and paid for. If hotels are being overvalued like the article suggests, the companies who run them will go broke but it will be bought by another company for a much lower value and run at an appropriate rate.

Wynn, Encore, Bellagio, Palazzo, Mandalay, Luxor, TI, Paris, Planet Hollywood and probably Aria and F-Bleau are structures that can last for a long time if not neglected. Some others like MGM and Stratosphere and (in the really long term) Venetian will need some renovations over the years to chop out the older bits (Marina/West Wing).

I don't think things will stop opening in Vegas, I think they'll just open in old hotels. Who says the next Must-See thing in town will open with a resort? Companies choose to implode these things when they turn 20, they aren't somehow designed to fall apart at that age. We're too concerned with seeing the Next New Thing, and instead what we'll see is longer-term thinking.

Another thing I hope we'll get rid of is this mentality that if you can't show a profit on paper, it doesn't exist. Things as simple as cheap food and things as expensive as water shows bring people into the casino to gamble. In WHHSH Vegas, food prices and hotel room prices and nightclub prices and all prices are high enough to drive their own profits, and simply packing them into the casino isn't good enough to justify keeping it around anymore. So everything is a cash register.

You can't put a dollar value on the money the Bellagio fountains have brought in. For one thing, it has attracted people to stay not just at the Bellagio, but Bally's and Paris and all the hotels around. You can't say "this is how much money the Bellagio fountains brought to the casino this year," but there's no doubt if they shut it down completely that a lot of money would disappear or at bare minimum move elsewhere on the Strip.

I will happily return to an age where the casino drives the profits and the other divisions serve as loss-leader billboards to get you inside. Having a steak for dinner was much more affordable then, even if you couldn't prove it to shareholders that I'd be elsewhere if it cost more.

Anonymous said...

Steve, pull out your 1955 Life Magazine. You'll see this is a rehash of what has been repeatedly said about Vegas over the decades, and it survived. What numbers don't account for is the human factor. Ask Wynn about that. While the luxury hotel market, just like real estate prices in general, may have been a bubble and need to adjust down, there was an obvious demand for it. Even on a global scale as international rates had still been climbing through 2007. People want new and improved, not the same-old, same-old.

Most people compare Vegas prices to 'old style Vegas', which is apples to oranges. When you compare rates with other destinations nationally and across the globe, it was middle of the road and often still a bargain among popular destinations. The luxury and amenities are what kept pushing the Vegas visitor numbers up in recent years, while casino properties sprang up all across the country.

The bargain hotels of Vegas gone by were the ones that struggled even during the boom years. Downtown Vegas revenues dropped for well over a decade plus. Trop, Riviera, Sahara, Westward Ho were all underperformers and why they were in play or sold. Their dirt held more equity than the business itself. Same for the Dust and "the biggest toilet on the Strip". Circus Circus and Excal are still bargain properties, but surely not the majority's choice when flying out to the desert for a vacation escape.

At the moment gloom & doom are in vogue in the media, an extension of the negative political campaigns. The same Congress that has sat on their thumbs since the housing meltdown began in 2006 is now rushing with a fix to the mess they allowed to happen. Perhaps to push their party's agenda, since you don't need new leadership unless there's a crisis. The totally ineffective Housing and Economic Recovery Act of 2008 finally passed in June of that year, two years after the fact, and less then 3 months before credit markets became frozen. All that time to study the issue, yet they appeared unaware of what was looming... and just before an election. Strangely enough, now legislation can get pushed thorugh in weeks instead of years.

Consumers, even those that have the resources, are tight with their cash because of the uncertainty this has created, and the focus is on despair. Once something begins to take shape they'll be looking for an escape from the stress they've been under, and Vegas will be one of the destinations. It's happened repeatedly through economic downturns, you only need to go back to 2001 when we were already in a recession pre 9-11, and then that disaster's added effect on the economy, and in particular travel.

Much depends on how effective whatever the stimulus actually is, and that's hard to say since it keeps morphing. In a worst case scenario, you'll see more bargains being purchased, like the Ruffin TI deal. At those numbers buyers have plenty of breathing room to ride out a storm, and a breather for consumers as well. It's not unlike the rest of Vegas real estate where today's buyers, residential or commercial, are picking up tremendous values. Even though it shouldn't become a flippers market again, thank god, it's still the classic Warren Buffet quote of "Be fearful when other are greedy, and greedy when others are fearful."

Those that sit back and wait for peak, or over-leverge when times are good, are the ones that take the hit, and those that know when to buy or be conservative with escalating prices, take the prize. I'm sure if you think about it for a moment, there are any number of businesses, hotels, and retailers that have come and gone over the years, or ownership changed, yet life moved on and there was growth. Most any fool can make money when the going is good, but a smart businessperson knows how to prepare for and read the ups and downs that are sure to come. It's not rocket science. Saving for a rainy day and buy low, sell high are old adages, and obvious proof of the recurring and cyclical nature.

The 90's rise and fall of Wall St. itself is another perfect example, and yet their creative greedy financing, that fostered more greed among the public and businesses alike, is the major factor of what has led to this current economic mess. Shame they couldn't analyze what was going on in their own world, when it was so close to home.


Anon: Life in 1955 was actually right. Vegas was overextended then. It took years for it to absorb its extra capacity and return to growth. It's fun to look at that cover now and say, 'boy was that reporter dumb' but he wasn't. he was correct for his time and economic situation.

Anonymous said...

Steve...yes Life was right for that point in time. The question is, did Vegas and not only recover and survive, but come back bigger and better then, and each and every time a similar article was written over the years? Yep, you bet, the cyclical nature of the beast. Swings are a common business and economic trait, not just for Vegas or it's casinos. Some are more extreme than another, each has it's peaks and valleys. This time around There will be any number of businesses that will reorganize or cease to exist, as has happened many times in the past, but life will go on and someone will take their place.

The next question, is any of this story really news for this point in time? What about this casino over-leveraging? Is this analyst providing a shocking revelation, or is it common knowledge?

He may have even stole insight from your Wynn interview. Didn't Wynn say something about along the lines of this crunch is "Shaking loose the men from the boys?" The 'Un-bundling of Vegas", that would have more individual owners watching smaller companies, and that along with the competition it was a better environment for both business and consumers? Un-bundling, why? To pay down debt? Why months ago MGM said it was exploring the sales of some of it's assets? Loveman saying they had been spending money like drunken sailors?

Didn't before reading this sucky story, think that Ruffin's move was 'Brilliant', picking up one of these unbundled assets at a super price? Gosh, thank god Phil didn't fall for this Skid Row disaster looming over Vegas like you've just done. He may have said 'Wait, Vegas sucks, some analyst / writer said so, and kept his money tucked in his mattress. Then MGM could have pulled an Echelon. Think of all the additional jobs lost. That would be great for the economy, right?

The advice given from the story teller, Captain Obvious, is to do what in this downturn? Vegas casinos need to offer value, do belt tightening, and pay down debt. No Shit? Really? Vegas, and every other business and household in the US hasn't figured that out yet? Wow, rocket science, huh?

Where was this analyst's stunning expertise on the Las Vegas casinos when this was taking shape? Why now does he point out the evils of the Vegas casinos after the fact, yet doesn't mention how they were able to do these reckless financial deals. Was it YEE-Gads, funded by none other Wall Street? Back in the day of the Life story, Vegas got it's loans from the other organized crime syndicate.

Yes, the real problem originated with Wall Street allowing credit to flow too easily. Thus making some companies, like MGM, think (an oxymoron) they could build the world's largest private construction project without having their financing locked in up front. They didn't even have the $5 billion from Dubai and they were already playing heavily in the sandbox. It's the same mentality generated by the Street by making home loans available for all comers. For existing homeowners, turn that roof over your head into an ATM, who cares if you can afford the payments, you've got equity to play with. While those that fell for the bait are just as responsible for their actions, Wall Street was the Pied Piper.

At that point in time, analysts showed the great returns in these funds and investors jumped on board in droves. That flooded more available cash to fund these shaky deals. Wall Street was in bed with Vegas, and flush with investor money for them or anyplace else, again leading by example.

Didn't an investment bank buy the Start? Didn't analysts say the initial stock offers for the Harrah's buyout, one of the largest leveraged in history, was undervalued? That also in spite of the $10 billion in debt Harrah's was already carrying at the time?

Gee wiz, and all those billions in equity the casinos lost in this article? Wasn't that a fall from perceived value fabricated by Wall Street Analysts? Have the casinos revenues fallen by the same percentage as their stocks, or is this a diminished value caused by fear? Vegas casinos, or any other traded business, don't set their own stock values.

This is also the same thing that happened with the Dot Com boom. Tech stocks soared on Wall Street advise, until that house of cards came tumbling down. It was all those under performing tech stocks that burst the bubble, right? Couldn't have been that Wall Street WAY overvalued them. No one cared. Everybody was making money in the market, well, until reality caught up with them.

This time the image the keepers of the Street created was that the endless money tree was there for the shaking, and again not just for Vegas. It played on another human trait....greed. The glow from the pot of gold went from Wall Street to Main Street and everywhere in between, blinding financial common sense of all the players that fell for the lure, and all the while our government watchdogs sat back at watched it happen.

How long a recovery will take is anyone's guess, and will vary from area to area. The rust belt continues to feel the 1980's loss of steel an manufacturing, and this situation may bury it deeper. Vegas has been a place known for reinventing itself, and for an escape from the stress of the day. That can act in it's favor as we have signs of progress. Much of the recovery depends on attitude, and why 'consumer confidence' is such a huge factor in the economy. Think negatively at anything you do and you're beat before you start.

So, is this story an objective use of the power of the media, or is it like a juicy tabloid style disaster that will grab a headline, using an attention getting brand like Vegas and singling out those greedy casino owners as the cause of all evil? Does it educate by showing the true cause, the effects of ignoring it, even by our own government? Does it offer a one sided negative slant, or a balanced view with potential solutions? Say like Sully, with him being up to his ass in alligators in a seemingly impossible situation. He'll chose to drown an airplane in the Hudson, but by heading the right direction and simply do what we need to do, we'll all survive and live another day?

Sorry, this was a dodge of the true causes with a focus only on the effect, and singling out a city and an industry. A rehash of the obvious with drama queen added with words like 'skid row' and 'dire' to glorify the popular gloom and doom theme of the day. It succeeded in only one thing, and that's reflected by your own impression in your title. It's another spin of....that sucks, and apparently sucked you into it's tale of despair. It's a cancer that needs a cure if we're to clean up this mess and move forward.

Anonymous said...

Vegas will turn when the consumer turns, and probably as a leading indicator. But until then there will be restructurings (Harrahs, LVS), closings (Riv, Trop) and some that will squeak by (Kerkorian's MGM). Then, we'll have happy days again. With a little humility.